Question

Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company's profits are driven by the amount of work Tom does. If he works 40 hours each week, the company's EBIT will be $590,000 per year, if he works a 50-hour week, the company's EBIT will be $705,000 per year. The company is currently worth $3.6 million. The company needs a cash infusion of $1.7 million and can issue equity or issue debt with an interest rate of 10 percent. Assume there are no corporate taxes a. What are the cash flows to Tom under each scenario? (Do not round intermediate calculations and enter your answers in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.) b. Under which form of financing is Tom likely to work harder? Debt issue and 40-hour week Debt issue and 50-hour week Equity issue and 40-hour week Equity issue and 50-hour week b. Which form of financing is Tom likely to work harder? 285,283 $ а.

Answer 1

Debt and 40 hour/week	Debt and 50 hour/week	Equity and 40 hour/week	Equity and 50 hour/week
590000	705000	590000	705000
1,700,000(cash Infusion)	1,700,000(Cash Infusion)	1,700,000	1,700,000
2,290,000(add above 2 values)	2,405,000	2,290,000	2,405,000
-170000(0.10*1700000)	-170000
2,120,000	2,235,000	2,290,000	2,405,000

Under Debt and 40 hour/week he is working harder as he gets 1.7mn but he has to pay an additional interest of 170000 unlike other options where the cash flow is higher , since the tax advantage is not mentioned in the case .